Certain types of life insurance products have a cash “account value,” and a consumer may have some ability to access that value and to try to increase that value. Consider, for example, a variable universal life insurance policy issued to a consumer for a given death benefit amount of $100,000. Over the life of the policy, he or she may make periodic, variable premium payments that are invested in investment options that, in turn, invest in mutual funds. In this case, the timing and amount of payments that have been made by the consumer and the performance of the investment options will, in part, determine the current cash account value associated with the policy.
The difference between the death benefit amount and the current account value of a life insurance policy is referred to as the Net Amount at Risk (“NAR”). For example, a life insurance policy with a given death benefit amount of $100,000 and a current account value of $30,000 has a $70,000 net amount at risk. That is, if the consumer dies at that point in time, an additional $70,000 needs to be paid by the insurance company in addition to the current account value in order to satisfy the death benefit amount.
To cover this risk, the insurance company applies a Cost Of Insurance (“COI”) charge to the net amount at risk, typically on a monthly basis. For example, the insurance company might apply a yearly cost of insurance charge that is calculated by multiplying the current net amount at risk by a cost of insurance rate associated with the policy (e.g., 1.10 per $1,000 at risk).
A single cost of insurance rate is typically applied to the entire net amount at risk each time the cost of insurance charge is applied (although the rate applied will depend on, for example, the duration of the policy, the consumer's age, and/or whether or not he or she smokes cigarettes). Note, however, that consumers who accumulate lower current cash account values (and thus have an increased net amount at risk) may pose more of a financial risk to an insurance company as compared to consumers who accumulate higher current cash account values. Since a single cost of insurance rate is applied to the entire net amount at risk, those consumers who accumulate higher current cash account values do not benefit from this lower level of financial risk. Moreover, the insurance company's ability to motivate consumers to increase their current cash account values may be limited.